Saturday, October 20, 2012

MTU Weekend Ed. - Dip (10/19/12 close)

Bottom line - The upswing in U.S. stocks since June likely ended in September.  Stage is being set for a potentially final but meaningful upswing of the Hope Rally.  It's probable that the Hope Rally was already complete in September, to be sure, but this more bearish scenario appears to be a less likely alternative at the moment.

After we posted Correction Approaching Its End (10/12/12), SPX rose 35 index points (or +2.5%) to Thursday’s high but failed to make a higher high.  Friday’s plunge effectively wiped out all the recovery gains. Moreover, the losses in Nasdaq indexes were about double their rebound gain, creating lower lows. It is interesting to note that Friday was the anniversary of the 1987 stock market crash as well as an option expiration day. In hindsight, our prior conclusion is not only short lived, but likely off by a wave degree.

The relative severity of Friday’s sell-off strongly suggests that the upswing since the June low likely ended at the September high for the broad market (Chart 1, red). Within the framework of our Hope Rally model, the September high is point number 5 and the current multi-week dip is likely on its way to reach point number 6, likely to be followed by a final but meaningful upswing to point number 7 (Chart 2).

Our Hope Rally model does allow point number 5 to be terminal (Chart 2), especially as the proverbial death cross is looming on the SPX monthly chart (Chart 3). However, this more bearish scenario appears to be a less likely alternative at the moment.  See below.

Silver linings
Potential support from key moving averages - As a result of Friday’s plunge, senior indexes are once again testing their 50-day SMA and Nasdaq indexes their 200-day SMA. These key moving averages represent potential support for the near term.

Still corrective wave structure since the September high - To date, the pullback from the September high is best counted as a three wave decline.  Two potential wave structure emerge  in the form of a W-flat-Y or W-triangle-Y (Chart 1, red).  The squiggle Chart 4 on SPX anticipates a small-degree 5th wave decline before a rebound per W-flat-Y or an immediate wave E rebound per W-triangle-Y early next week. A subsequent final decline is likely to follow to complete wave Y of these structures.  A potential target zone is around 1390/1400 in SPX.

Near term positive divergence from market internals - In contrast to the negative divergence seen during the prior upswing, the SP500 advance-decline line was able to make a higher high last week and hold its ground (Chart 5).

Potential near term VIX consolidation - VIX once again reached its upper Bollinger band.  Chart 6 shows a potential sideways consolidation in VIX in recent months, potentially a wave B counter trend move.